For for-profit enterprises, business success begins and ends with the financial ledger. Markets and regulators are quick to correct overexpenditures and lax compliance.
IT financial management is a foundational component of enterprise-wide financial health. CIOs are required to demonstrate fiscal discipline to their colleagues and shareholders. The implications of this obligation are as enormous as they are obvious. IT leaders contend with a host of financial challenges and investments every day, mandating and reviewing capital expenditures (CAPEX) and operating expenditures (OPEX) while grappling with the ramifications of legislation such as the Sarbanes-Oxley Act.
According to IDC, we are in the midst of a technological inflection point in which a multitude of factors have made this ongoing obligation all the more pressing. The average cost of central IT has risen to 5 percent of sales. At the same time, digital transformation initiatives are seen as central to long-term enterprise viability, and many IT costs are assumed by non-IT lines of business.
IDC reports that high-performing organizations are able to contend with this increased complexity through effective IT financial management with “a professional, mature, and rigorous emphasis on the modeling tools and data structures that are needed to perform the in-depth managerial accounting analyses.”
“IT financial management is a critical activity for CIOs to make sure their firm gets the value from their technology investments for the money they pay,” says Andrew Bartels, vice president and principal analyst at Forrester Research. “But IT financial management plays a different role in new project tech spending than it does in ongoing operations, maintenance, and support tech spending.”
According to Bartels, when it comes to new project spending, “IT financial management involves assessing the initial and future costs of a new technology capabilities versus the business benefits, typically using return-on-investment calculations.”
For IT-initiated projects, Bartels explains, success is contingent upon complete financial management with an eye towards “calculations for flexibility benefits and risks in addition to direct costs and direct benefits.” For business-initiated projects, he continues, “the CIO’s IT financial management skills will be used to help business partners identify all the financial benefits of the new technology as well as all its longer-run costs.”
New technology spending, then, is an opportunity for discovery and ROI-focused implementation. By contrast, ongoing technology spending is an opportunity for cost optimization and contract oversight.
“In ongoing technology spending, IT financial management involves gaining insight into which costs are fixed by contract, which costs can and should vary based on contract terms, what costs can be eliminated (for example, by retiring old or redundant systems), and what costs can be reduced (whether through elimination or more efficient processes),” Bartels says.
It is clear that finance is more than the language of business – it is the DNA. IT leaders have an incredible opportunity to make financial impacts that will help define their organizations’ futures. In this edition of CIO Quick Takes, CIOs reveal the most important lessons in IT financial management that they have learned — and, most importantly, how they apply those lessons in the enterprise.
Bradley Strock, CIO, PayPal
I would say the most important lesson about IT finance is that it is business finance. What I mean by that is the language of business is finance, and it is fundamental to conducting business anywhere. So, while there are certainly particular nuances to IT from a financial perspective, I view all of it as business finance. Whether it is determining what projects to invest in, evaluating the efficiency of processes, or [evaluating] how technology is contributing to the growth of the company, finance is the primary tool we use in business.
What I often find with technologists is that they lack even the basics of how finance is used in a business. If the language of business is finance and you can’t speak even the basics of that language, it means you are missing out on the fundamentals of the enterprise of which you are a part. Basics like the difference between operating expense and capital expense remain a mystery for many engineers.
Perhaps I’m biased because I came from a finance background very early in my career. In fact, I only half-jokingly tell people that if I hadn’t become a CIO, I might have ended up as a CFO. But the truth is that having a basic grasp of core financial concepts is extremely important to being a successful technologist, especially at the leadership level.
So, take the time to invest in yourself and learn the basics. Be able to read and understand a simple Income Statement and Balance Sheet. Know how capital spending becomes an asset and then depreciates, becoming an operating expense. Understand the difference between income and cash flow. The aim is not to become a CPA, but to be able to be conversant in the lingua franca of business … finance.
Ron Guerrier, CIO, Farmers Insurance
The most important lesson that I’ve learned about IT Finance comes with the prep, polish, and presentation.
Most IT professionals don’t think too much about the evangelism needed to get IT initiatives funded and launched. I’ve learned that taking the extra time to ensure that you’ve prepared all the necessary documents and all accounting treatments are true. The next learning is that the details must be polished, as the flow and logic must tell a story that resonates with those approving the request. The final step is a presentation that not only provides low-, mid-, and high-cost options with a recommendation, but also has a few mock-ups or wire frames that give a visual deliverable. On the latter, it’s worthwhile to create these samples with diminishing features based on the low-, mid-, or high-option chosen. In a world of agile, proof of concepts, etc., this should be an output at inception.
Embedding a finance subject matter expert on your team will ensure the economics are sound. And if you apply the right preparation, polish, and presentation, you’ll find success in getting your IT project through the finance gauntlet.
Jamie Cutler, vice president and CIO, Qep Resources Inc.
In my time leading technology, process and information teams in various industries, there is one lesson I have learned that continues to hold true today and will in the future. As a leader in any organization, no matter the level or title you hold, being able to tie investment to results is the most important financial discipline you can put into place in your organization. Corporate leaders, boards, and heads of operations discuss profit and loss, cost of goods, cost of sales, and operating expense. As a company leader, you need to speak the same language. Too often I hear IT personnel talk about IT as a “fixed” cost or as a cost of doing business. The paradigm of IT has shifted and thus as leaders we need to use the same concepts and measuring sticks as our peers across the company. The key is to hold yourself and your team accountable for results based on financial investment.
Start with tying projects to results; talk with your executive steering committee about the “why” of projects and the expected results from each effort, and classify projects based on the “area” of a project. Is the project for future efficiency, is it for process improvement, or is it driven by a regulatory requirement? What did the project return to the company? How do you measure return on the project? Have criteria that you have already vetted with your peers around how to measure this return (hours returned to employees, faster to market time, better consumer experience, etc.). Use both empirical, number-based data and anecdotal information from business units to measure the return; both of these criteria have a place in the discussion.
Expense investment can be more difficult to quantify on a return basis. My belief with expense is that every dollar spent in IT should show a value back to the company in some manner. Use broader more service-level conversations for expense dollar investments. What levels of service are purchased with the investment? How does this compare with “as a service” vendors and other external providers? Show how your metrics compare with those of external providers. Don’t forget security, either. Quantifying the idea of keeping your employees and customer’s information safe is an investment, and the downside, as we all know, is far greater than the investment. Keep in mind, security is not a zero-sum game; enhancing security tools and process can increase safety and increase usability. The financial industry has been successful in enhancing security while increasing usability.
The key to financial investment is to know where your IT dollars are going and then to have the dialogue across the organization about those investments in results terms, not IT terms.
Peter Weis, vice president and CIO, Matson
As the pace of technology change accelerates, there’s a strong tendency for CIOs to expend great energy worrying that their skill sets are constantly on the brink of obsolescence. As I reflect on the technology waves of the previous 20 years, I think that worry is largely misplaced. Staying technologically current is in our genes. It’s who we are and how we’ve been trained. Technology is our native language.
Conversely, the CEO’s native language isn’t technology. It’s finance. A CEO’s success is directly tied to the ability to improve a company’s financial levers: EPS, ROIC, EBIDTA, P/E, NPV, and WACC are core elements of this language, and it’s the language CIO’s must master. Over time, I’ve learned to largely spare them the acronyms of my native tongue. I mention SaaS, PaaS, SDN, VoIP, DLP, and IAM sparingly and only when necessary as they relate to business issues: top line growth, margin improvements, customer experience, or risk mitigation.
Great CIOs must be viewed as “moving the needle” in the CEO’s eyes. Building fluency in the language of finance is among the fastest ways to a corner office and was also critical for me in performing a “CIO+” role. My financial acumen played a key role, as I was entrusted with starting up and operating a global supply-chain business unit for four years.
How does one become viewed as a needle-moving CIO? Here are five quick tips:
Learn your company’s financial levers and metrics so that your entire team understands how your company’s performance is measured by the board, investors, and outside analysts.
Train your entire IT leadership team so that corporate finance is baked into your team’s DNA. Sell the vision and insist on commitment.
Build the best financial models in your company. CIOs who demonstrate financial rigor when analyzing IT investments build trust and credibility. Demonstrating financial stewardship translates into greater success in competing for your company’s scarce capital.
Cut discretionary, soft-benefit enhancements as a way to fund real innovation. You’ll gain respect as an innovator and as a leader who is unafraid of making tough calls. Be both a shrewd investor and a fearless cost cutter.
Avoid the “CEO squirm factor.” Use financial language wherever possible in C-level and board meetings. Avoiding needless technology jargon builds rapport and demonstrates that you too are the business.
While it’s common for us to progress in our IT careers without mastering these skills, it’s also ultimately career-limiting. IT executives who master this second language are more likely to get hired, to get promoted, and to have a seat at the executive table.
Technology skills are necessary for success, but they’re not sufficient. Finance skills are seen as more scarce and in many CEO’s eyes, more valuable. I wish I’d learned this sooner.
Raj Kushwaha, CTO and managing director, Warburg Pincus
Today, there is no argument that technology enablement and digital transformation creates a multitude of benefits for businesses and is increasingly becoming a material cost line in company P&Ls. However, effective measurement and management of technology ROI still remains an elusive challenge. To bridge this gap, technology leaders not only have to be cutting-edge technologists, but they also need to have a strong commercial/financial acumen.
A significant change for technologists in my view is in how to think about structuring technology investments. Some best-in-class disciplines include structuring all technology innovation projects as venture capital bets, defined with narrow and near-term success criterions, have clear financial measures, are organized around individual accountability with cross functional governance, and are structured as “fail fast” bite-sized agile initiatives. A very important concept in failing fast is to celebrate and learn from failures rather than marginalize their value by ignoring them.
The above generally represents a material culture change for most companies that have for decades organized technology initiatives around long-life projects with annual budget approval cycles. This turns all historical technology planning, and budgeting assumptions on their head.
The approach requires adding a rigor for thinking about technology spend in two distinct buckets. The first being the lights-on bucket, which represents the true maintenance costs of technology and should scale with revenue, just like any other operational function. This component should be the only component part of the annual budget cycle and subject to normal cost optimization approaches.
The second bucket, hopefully the bigger bucket, should be the technology innovation bucket, which should be structured as a series of venture capital bets with a level of innovation funding the company is willing to make on an annual basis with an aggregate expectation of 3X quantified returns over a three-year period.
The venture funding should support a portfolio of bets (projects) that have different risk profiles and risk horizons, all structured with near-term incremental success criterions that are brutally transparent and cleanly measurable, and are governed with a venture board like governance comprised of cross-functional leaders. It should be acknowledged and celebrated that about 30 percent of the best will fail, but the balance will deliver a material and measurable ROI, which in aggregate returns 3X money for the annual innovation spend level. Key being a measurable returns requirement, just like a successful venture bet would have.
More progressive companies can even extend the concept by linking variable compensation of teams to venture returns with success multipliers for annual value creation. This venture approach to innovation spending not only creates a maniacal focus on technology-enabled value execution, but it also forces technologists to start thinking about financials and returns more so than they normally would. Also, it forces the discipline of six- to nine-month value creation cycles that can measurably drive variable compensation.
The venture approach to innovation spending can be transformative and represents a culture shift for organizations — from that of managing technology spending to that of technology investing — and a skill set shift for technology leaders — from being technology CIOs to venture-backed CEOs.